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Calls under performance bonds: greater leniency in Scotland?

A recent Scottish Inner House decision provides an overview of the approach to be taken in Scotland to interpreting performance bonds. The decision notes that the degree of compliance required when making a call may be strict, or not so strict, depending on the construction of the bond. The court’s decision also refers to the commercial purpose of the bond being key and may suggest that a more lenient approach to performance bonds is to apply in Scotland. The decision also contains an interesting finding that an anticipatory breach is sufficient for the purpose of “stating a breach” under such a bond.

Coface SA v South Lanarkshire Council

Coface granted a performance bond in favour of South Lanarkshire Council as security for the land restoration obligations of the operator of an open cast mine, the Scottish Coal Company Limited (“Scottish Coal”) following the cessation of mining operations.

The bond: (1) contained calling up provisions; (2) stated that the maximum aggregate liability was fixed at £4,499,411; and (3) set out variable limits on liability which were index linked. The bond was expressed to respond in the event of a “breach of the Restoration Obligations” agreed by Scottish Coal.

Interim liquidators were appointed to Scottish Coal on 29 April 2013. They later informed the Council that Scottish Coal’s funds were insufficient to pay for any restoration works.

The Council wrote to Coface on 1 May 2013 stating that it was likely that the bond would be called up. On 29 May 2013 the Council sent a notice intended to call up the bond which stated the original cost of the restoration works but did not specify the sum that Coface was being asked to pay.

Coface did not consider a valid demand had been made and did not make payment. The Council raised proceedings in the Commercial Court of the Court of Session. At first instance, the Commercial Court rejected Coface’s argument. Coface appealed to the Inner House.

The Two Stage Process

Coface argued that the wording of the bond required any call to be a two-stage process. First, notice in writing of the breach must be served. Second a demand for payment. It maintained that the letters received did not fulfil these requirements and, specifically did not demand payment of a specified sum. As the bond contained provisions for different levels of liability at different times and required index linking, the sum demanded was not known.

In rejecting Coface’s argument, the court said that the bond “must be construed in a practical manner, in accordance with commercial common sense, and in such a way as to further the parties’ common intention and the essential purpose of the performance bond. An unduly technical construction should be avoided.”

The court accepted that the cost of the restoration works is not the same as the amount due under the bond. However, it considered Coface could easily examine the terms of the schedule to the bond, carry out the index-linking exercise and determine its liability.

Anticipatory Breach

Coface also argued that the notice did not state in plain terms what the breach of contract was other than stating that there had been a breach of the Restoration Obligations. Coface argued that specification of the precise breach that had occurred was required.

The court rejected this argument stating the bond merely requires “notice in writing of any breach”.The court said that such a breach might occur “at an anticipatory stage” where it became apparent before the termination of mining operations that Scottish Coal was insolvent and would be unable to carry out the restoration works.

Conclusions and Implications

This decision appears to show the Scottish courts adopting a more lenient view when interpreting calling-up provisions within bonds, indicated by the many references to “commercial common sense”. This contrasts with recent decisions of the English courts in the sphere of on-demand bonds where the doctrine of strict compliance remains. It is conceivable that an English court may have required the Council to state expressly what amount was demanded from Coface under the bond.

The indication that an anticipatory breach is sufficient, in certain circumstances, for stating a breach under such a bond, also suggests a greater leniency in approach. The court has taken a broad view of what might constitute “a breach of the Restoration Obligations”. Such an approach potentially has wider implications for the calling of securities in insolvency situations or where claims are made following the termination of a construction contract which must await assessment following completion of the works. In such circumstance, the need to specify an existing rather than future breach of contract can pose difficulties.

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